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Superannuation needs a sustainable framework

What does a sustainable superannuation system look like? And do the reforms announced by the Treasurer make our system more or less sustainable?

Let’s start with the first question. My assumption is that superannuation is ‘forced’ savings that are designed to reduce retirees' reliance on the government-funded old-age pension. Those who can afford to save enough during their lifetime to take financial care of themselves in their old age should be encouraged to do so.

But if this is the underlying principle, our superannuation system clearly lacks one key element.

At present, if you are over 60 and retired, you can take your superannuation as a tax-free lump sum. You can spend it or arrange your affairs so that your income is reduced and you are at least partially eligible for the pension.

In contrast, a sustainable superannuation system would require retirees to turn their superannuation savings into a flow of income (a lifetime annuity). This would reduce the pension paid to retirees by the government. Tax benefits on superannuation savings would make sense because they would help reduce future government pension liabilities. The old-age pension would be a true safety net.

I have discussed this before. Alan Kohler notes that such required lifetime annuities are used in the UK and Canada.

If the government does move to an ‘annuity’ approach, how should it tax superannuation contributions? At present this is a ‘dog’s breakfast’, as John Freebairn explains.

So let’s do a little ‘hypothetical’. Given the current old age pension, what level of superannuation contribution would be ‘neutral’ for the government in terms of revenues and receipts. I will work from the single pension which I will round up to $20,000 per year. This is income tested. So if your income exceeds about $4,000 per year you start to lose the pension at a rate of 50 cents for every extra dollar of income. Your pension is eliminated once your annual income (as a single person) exceeds about $44,000.(The rounding means my figures are approximate - but fine for illustrative purposes).

Now, suppose that you receive income from an annuity that you were required to buy with your superannuation. Then if your annuity payout was between $4,000 and $44,000 per year the government would save 50 cents for every extra dollar you receive in your annuity every year. So if you save another dollar in superannuation then the government saves about 50 cents in terms of the present value of future pension payouts.

In this sense, a tax concession of up to 50 cents per dollar saved as superannuation would be roughly ‘revenue neutral’ for the government.

Of course, if your annuity is more than $44,000 per year then you save the government nothing. You are ineligible for the pension and an extra dollar in superannuation simply gives you a tax concession with no reduced government spending when you retire.

Or put another way, if your superannuation balance is more than about $1 million, the tax concession on further superannuation savings is a cost to the government without any offsetting benefit to the government when you retire.

So how should the superannuation system be reformed? Introduce a ‘required annuity’. Rationalise the hodge-podge of taxes while at the same time designing the pension scheme to mesh seamlessly with the superannuation system. And introduce a tax on superannuation income for those retirees who are ‘clear’ of the pension thresholds.

So what did the Treasurer do? He announced one of these changes - which is better than nothing. The reforms “[c]ap the tax exemption for earnings on superannuation assets supporting income streams at $100,000, with a concessional tax rate of 15 per cent applying thereafter …”.

Now this is a long way above $44,000 but the press release does ‘tie the figure’ back to the current pension. Good!

Also, 15% is not 50%, the current effective marginal ‘tax rate’ for a pensioner who loses 50 cents pension for each extra dollar earned. But this is probably a good thing because a higher tax rate would just lead to more ‘rearranging’ of retirees' affairs to avoid the tax.

But clearly this is just a first step. The pension and superannuation systems need to be thought of as a single system. This means that some or all of superannuation savings have to become a ‘pension replacing’ annuity. It means the income testing for the pension needs to be tied into the superannuation tax concessions. More broadly, it means clarifying the role of government and individual responsibility for retirement.

We have taken the first step. Now the government needs to take a few more.